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Altera Corporation (ALTR) is one of the two dominant programmable logic devices [PLD] companies. The $3.7B PLD business is a high margin, high barrier to entry business. Because each PLD vendor's product offering is proprietary, the cost to switch PLD devices after a system has been designed and prototyped is very high. Therefore, a design win can provide the PLD vendor with a profitable revenue stream through the life of the customer's program. From the time a design win is secured, it can be as long as two years, and sometimes longer. The barrier to entry for this business is the IP around programming toolsets. Altera and Xilinx together control 80%+ of the PLD market.

Altera’s products can also be thought of as New, Mainstream and Mature. The new products are the latest versions of Stratex (high end), Cyclone(low end FPGA), Hardcopy and Max-2 [CPLD] products. Mainstream products are the existing version of Stratix, Cyclone and Max devices. Mature products include FLIX and APEX product lines. Growth rates in the new product stream will be highest and will constitute a larger portion of revenue going forward

End market exposure

Communications and Industrial comprise 70%+ of the revenue mix. Altera should grow 2x the communications space going fwd. Given that communications should grow 5% in 2007, ALTR will grow at least by 10%. Industrial and Consumer will lead in YOY growth, with Computers and Storage being laggards. On a blended basis, Altera will grow top line 12-13% in 2007. ALTR will grow top line a substantially higher pace in years 2008-2010; ultimately at an 18% CAGR 2006-2010. Altera is fables; they outsource manufacturing to TSMC. Hence they do not have the costs OR leverage benefits of owning a high fixed cost business.

Gross margins are between 65-67%. R&D(19%) and SG&A(24%) are the main cost drivers. Capex requirements are minimal. Given the accelerating growth going forward, the operating costs will significantly reduce as a % of revenue through 2010 (I expect 15% R&D; 16% SG&A in 2010). Altera’s capital structure is a cash generating machine. Altera has a market cap of $7B, and ~$1.6B in cash. 2006 FCF was ~400mm, which should accelerate to ~$1B by 2010. Given the current market price, the company can buy back 50% of outstanding shares by 2009. Assuming share buyback, the company currently trades at 8x 09-EPS.

My target R&D and SG&A estimates are lower than the LT company target. Given the company profile and the revenue run rate, the current SG&A and R&D should increase ~$50mm YOY on average. This argument makes me conclude that the LT financial targets would be met in 2008. Option expenses should grow 5% YOY in tandem with the overall economic growth.

So is it a buy now? Well, like its semico brethren, ALTR should have a bad March quarter. Stock may get choppy. But I think revenue will accelerate in H2-07. The street has a revenue estimate of ~1350 for 2007 – mine is 100mm+. So lets see how H2 plays out. However, this definitely is a LT cash play.

Disclosure: Author has a long position in ALTR

ALTR 1-yr chart

Source: Altera Corporation: A Cash Machine